Trough Phase

In the previous chapter, we have briefly discussed the contraction phase of the economic cycle.

Now, moving ahead to another phase of the economic cycle, the trough phase.

The trough phase is the period when the economy hits its lowest point after a recession. During this phase, economic activity is at its weakest, with key indicators such as gross domestic product (GDP), employment rates, industrial production, and consumer spending reaching their lowest levels. However, the trough also signals the end of the economic decline and the beginning of the recovery phase.

The duration of the trough phase may vary depending on the severity of the previous recession and the effectiveness of policy responses.

Causes of Trough Phase:

Interest Rate Peaks: Central banks raise interest rates during economic expansions to curb inflationary pressures. As interest rates reach peak levels, borrowing becomes more expensive for businesses, consumers, spending, and even investment.

Consumer Spending: After a long period of economic decline, consumer confidence and spending decrease due to job losses, reduced incomes, and uncertainty about future economic conditions.

Business Investment: Businesses reduce capital spending and demand for new projects weakens, leading to lower production and increased idle capacity.

Monetary Policy: During the trough phase, central banks use expansionary monetary policies to boost economic growth. This involves reducing interest rates to promote borrowing and investment, injecting liquidity into financial markets, and potentially adopting quantitative easing measures to decrease long-term interest rates and bolster asset prices.

Fiscal Policy: Governments increase spending on infrastructure projects, unemployment benefits, and other social programs to boost aggregate demand. Government may also introduce tax cuts to provide relief to businesses and consumers, encouraging spending and investment.

Market Correction: Financial institutions and businesses focus on reducing debt levels and repairing balance sheets damaged during the recession. This process may involve asset sales, debt restructuring, and improving liquidity positions to strengthen financial stability.

Economic Impact of Trough Phase

Unemployment Rate: Unemployment usually peaks during the trough phase as businesses adapt to reduced demand and lower production levels. Job losses across different sectors contribute to high unemployment rates, which can persist even as the economy starts to recover.

Consumer Behaviour: The lack of confidence among consumers is resulting in careful spending habits, with a focus on purchasing only essential goods and services. This cautious behaviour is slowing down the economic recovery, as businesses are experiencing reduced demand for non-essential products and services.

Business Activity: Many companies may be operating below their full production capacity because they have more production capabilities than they need, and there is not enough demand for their products or services. As a result, they are not investing as much in their businesses until they see clear indications of long-term economic improvement and higher profits.

Financial Market: Financial markets, initially volatile, stabilize as policy interventions and improving economic indicators restore investor confidence. Stock markets may start to recover, and credit conditions gradually ease as banks regain confidence in lending to businesses and consumers.

Example

The Great Depression (1930s):

During the 1930s, the Great Depression hit its lowest point with severe deflation, numerous bank failures, and widespread unemployment. The period of recovery was characterized by a slow process, requiring significant government intervention in the form of public works projects and financial reforms as part of the New Deal. These measures aimed to boost demand and rebuild confidence in the economy.